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Wednesday, November 29, 2017

Moody’s upgrades India’s sovereign bond rating after 14 years

—the
rationale

Moody's
Investors Service has upgraded the Government
of India's
local and foreign currency issuer ratings to Baa2 from Baa3 and
changed the outlook on the rating to stable from positive. Moody's
has also raised India's long-term foreign-currency bond ceiling to
Baa1 from Baa2, and the long-term foreign-currency bank deposit
ceiling to Baa2 from Baa3. The short-term foreign-currency bond
ceiling remains unchanged at P-2, and the short-term foreign-currency
bank deposit ceiling has been raised to P-2 from P-3. The long-term
local currency deposit and bond ceilings remain unchanged at A1.
According to the Moody’s PR on 14 November 2017, a rating committee
was called to discuss the rating of the India, Government of. The
main points raised during the discussion were: The issuer's economic
fundamentals, including its economic strength, have not materially
changed. The issuer's institutional strength/ framework have not
materially changed. The issuer's fiscal or financial strength,
including its debt profile, has not materially changed. The issuer's
susceptibility to event risks has not materially changed.

The
decision to upgrade the ratings is underpinned by the expectation
that continued progress on economic and institutional reforms will,
over time, enhance India's high growth potential and its large and
stable financing base for government debt, and will likely contribute
to a gradual decline in the general government debt burden over the
medium term. In the meantime, while India's high debt burden remains
a constraint on the country's credit profile, Moody's believes that
the reforms put in place have reduced the risk of a sharp increase in
debt, even in potential downside scenarios. While a number of
important reforms remain at the design phase, Moody's believes that
those implemented to date will advance the government's objective of
improving the business climate, enhancing productivity, stimulating
foreign and domestic investment, and ultimately fostering strong and
sustainable growth. Measures include the Goods and Services Tax
(GST) which among other things, is expected to promote productivity
by removing barriers to interstate trade; improvements to the
monetary policy framework; measures to address the overhang of
non-performing loans (NPLs) in the banking system; and others which
work towards fostering stronger institutions and a more formal
economy.

Moody's
expects real GDP growth to moderate to 6.7% in the fiscal year ending
in March 2018 (FY2017-18). However, as disruption fades, assisted by
recent government measures to support SMEs and exporters with GST
compliance, real GDP growth is expected to rise to 7.5% in FY2018-19.
Longer term, India's growth potential is significantly higher than
most other Baa-rated sovereigns. While India's high debt burden
remains a constraint on the country's credit profile, Moody's
estimates that the reforms put in place have reduced the risk of a
sharp increase in debt, even in potential downside scenarios.

The
upgrade comes within five years of India being classified as one of
the "fragile five" economies, struggling with high twin
deficits in fiscal and current accounts. Since then a
combination of policy decisions and external factors has worked in
favour of an upgrade. The Finance Ministry has held on to the targets
for fiscal deficit, while the current account has been bolstered by a
period of low oil prices followed by a resurgence of global trade.
India’s position in the World Bank’s Ease
of Doing Business
rankings jumped up by a record 30 notches to the 100th spot recently
with relevant policy easing. The upgrade has been termed overdue by
some as India was earlier in the same risk category as a number of
economies with far worse macro-economic performance. Indeed a
Bloomberg
Economics
model had predicted an upgrade based on the divergence between actual
ratings and CDS implied credit ratings.

—the
benefits

The
sovereign rating is an indicator of the government’s ability to
meet its financial obligations. Sovereign credit ratings give
investors insight into the level of risk associated with investing in
a particular country and also include political risks. An upgrade
thus lowers the cost of borrowing for the sovereign as it is
associated with lower risk. In Moody’s rating, scale, bonds rated
Baa3 and above are considered to be investment grade, meaning, these
bonds are likely to meet the payment obligations better. India was at
the lowest rung of the investment grade until it received this
upgrade. The Indian government, it may be noted, does not fund its
deficits via offshore commercial bond markets. External debt as a
percentage of the Central Government’s total liabilities was at
6.2% in 2015-16. The entire public debt of India is funded via the
domestic Rupee (INR) bond market. Foreign investor participation in
the bond market, though increasing is very little, and tightly
regulated through quotas. However, there are certain other
benefits to be derived from a sovereign upgrade.

Sovereign
ratings also act as the benchmark for other issuers of debt in the
country. Effectively, sovereign upgrades or downgrades can affect
borrowing costs for companies, individuals and any entity looking to
raise money overseas. Moody’s upgraded some Indian corporate
entities, mostly public sector companies along with the sovereign
upgrade. This would result in reduction in cost of borrowing for
Indian companies looking to raise financing from offshore bond
markets. In fact, Reliance recorded the tightest ever spread for
an Indian issue over US Treasuries in the offshore market soon
after the upgrade.

The
sovereign rating is an important indicator of the country’s
financial and fiscal health. Foreign investors looking to commit
money to direct investments, portfolio investments or local bond
markets will all tend to look to the sovereign rating for a quick
assessment of the country’s prospects. A ratings upgrade gives
out a positive view on policy and builds incremental confidence in
foreign investors. A higher rating can increase the range of
investors, for example, drawing in global Pension and Life Insurance
firms that have minimum ratings criteria for investing. Incrementally
higher foreign flows tend to bid up INR too, making investments in a
host of other Indian financial assets like equities and real estate
more attractive to foreign investors.

—and
the caveats

Moody’s
mentions that a material deterioration in fiscal metrics and the
outlook for general government fiscal consolidation would put
negative pressure on the rating. The rating could also face downward
pressure if the health of the banking system deteriorated
significantly or external vulnerability increased sharply. The
upgrade has come in at a time when a gamut of short and long-term
indicators has started to worsen. Given the emerging signs of
quickening inflation and a widening current account and fiscal
deficit a lot of policy balancing is in order.

S&P
Global Ratings and Fitch Ratings, who now rate India a notch below
Moody’s, hold the view that for an upgrade, India would have to
address its weak fiscal balance sheet and weak fiscal performance.
S&P Global Ratings, while acknowledging India’s stronger growth
prospects and the country’s achievements on the reforms agenda,
noted that its ratings were constrained by India’s low wealth
levels, measured by GDP per capita. This and the income inequality
hidden behind it, is indeed a macro-economic indicator which, on its
own, needs far greater policy attention and careful planning than it
has received so far.

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